E2148 Debrief B: US Equities as a global store of value?
The valuation gap between the US and the rest of the world has continued to widen
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We covered a lot of ground on the call this week, so instead of one, very long weekly email, I’m breaking it up into a few parts. This is the second post, and provides a summary of a research article that Hunt mentioned during the podcast. If you are looking for the supplemental data that I provide each week, you can access it here: E2148 Debrief A: Supplemental Data.
Reserve Currency & Store of Value
Charles Gave of Gavekal Research published a research article this week where he said…
… most of the market commentators I like and respect have argued that with US budget deficits continuing to expand, and with the Fed maintaining ridiculously low real interest rates and monetizing the record budget deficits like never before, either the US dollar or the US treasury market - or both - should start to crumble under the twin pressures. Yet, this has failed to happen. Moreover, contrary to most peoples exceptions, the valuation gap between the US and the rest of the world has continued to widen.
He suggests that the old monetary system (as described by Jacques Rueff in The Monetary Sin of the West) which started in 1960, where the US dollar was the global means of exchange and standard of value and the German Deutschmark (and later, Euro) was the global reserve of value ended in 2012.
In 2011, Mario Draghi took over at the ECB became famous for saying that he would be prepared to do "whatever it takes" to prevent the euro from failing. Gave demonstrates that while Draghi may have saved the euro, he ended the 72 year run of the Deutschmark/Euro being the worlds store of value.
As a result, the previous trend whereby the US current account deficit that previously flowed back to the US in the form of foreign central bank purchases of US treasuries at a ratio of 4:1 no longer holds.
So where did this money go? Grave eliminates Chinese government bonds, gold, and crypto as explanations and lands on an interesting conclusion: the US equity market has become the new reserve of value and the missing money has been pumped into equity markets via passive indexing. As a result the US equity market has doubled since 2012 and the US account deficit has continued to widen.
Grave suggests 2 paths that could stem from this realization.
We could see continued increases in US equity markets as a result of the expected continued widening of the US current account deficit, and the fortunes of poorer countries running current account deficits may be especially perilous - Turkey, Egypt, Algeria may wind up like Lebanon (bankrupt).
A bear market in US equities leads to a fall in the US dollar and a narrowing of the US current account deficit. Driving up energy prices and accelerating inflation.
I’m still noodling through my assessments on Grave’s perspectives here, but would love to hear your thoughts. Feel free to respond to this email, or in the comments below.
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